7 factors lenders look at when reviewing your loan application
You want to do your best when you apply for a mortgage, car loan, or personal loan, but it can be difficult to do when you’re not sure what your lender is looking for. You may be aware that they usually look at your credit score, but that’s not the only factor that banks and other financial institutions take into account when deciding to work with you. Here are seven you should know.
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1. Your credit
Almost all lenders look at your credit score and report because it gives them insight into how you are handling the borrowed money. A bad credit history indicates an increased risk of default. This scares many lenders because they may not get back what they loaned you.
Scores range from 300 to 850 with the two most popular credit scoring models:
The higher your score, the better. Lenders typically don’t disclose minimum credit scores, in part because they consider your score in conjunction with the factors below. But if you want the best chance of success, aim for a score in the 700 or 800 range.
2. Your income and employment history
Lenders want to know that you will be able to repay what you borrow, and as such, they need to make sure that you have sufficient and consistent income. Income requirements vary depending on how much you borrow, but in general, if you borrow more money, lenders will need more income to be confident that you can meet the payments.
You will also need to be able to demonstrate stable employment. Those who work only part of the year or self-employed people who are just starting their careers may have a harder time getting a loan than those who work all year for an established business.
3. Your debt ratio
The debt to income ratio is closely related to your income. This looks at your monthly debt as a percentage of your monthly income. Lenders like to see a low debt-to-income ratio, and if your ratio is over 43% (so your debt payments aren’t more than 43% of your income), most mortgage lenders won’t accept you.
You can still get a loan with a debt to income ratio greater than this amount if your income is reasonably high and your credit is good, but some lenders will turn you down rather than take the risk. Work on paying off your existing debt, if you have any, and reduce your debt-to-income ratio to less than 43% before you apply for a mortgage.
4. Value of your guarantee
Collateral is something you agree to give to the bank if you are unable to meet your loan payments. Loans that involve collateral are called secured loans, while those without collateral are considered unsecured loans. Secured loans usually have lower interest rates than unsecured loans because the bank has a way to get their money back if you don’t pay.
The value of your collateral will also partly determine how much you can borrow. For example, when you buy a house, you cannot borrow more than the current value of the house. This is because the bank needs the assurance that it will be able to get all of its money back if you are not able to keep up with your payments.
5. Amount of the deposit
Some loans require a down payment, and the amount of your down payment determines how much you need to borrow. If, for example, you buy a car, paying more up front means you won’t need to borrow so much from the bank. In some cases, you can get a loan with no down payment or with a small down payment, but be aware that you will pay more interest over the life of the loan if you go this route.
Lenders like to see that you have money in a savings or money market account, or assets that you can easily turn into cash beyond the money you are using for your down payment. This reassures them that even if you experience a temporary setback, such as losing a job, you will still be able to keep up with your payments until you get back on your feet. If you don’t have a lot of cash on hand, you may have to pay a higher interest rate.
7. Loan term
Your financial situation may not change much over the course of a year or two, but over the course of 10 years or more, your circumstances may change a lot. Sometimes these changes are for the better, but if they are for the worse, they could affect your ability to repay your loan. Lenders will generally feel more comfortable lending you money for a shorter period because you are more likely to be able to repay the loan in the near future.
A shorter loan term will also save you more money because you will be paying interest for fewer years. But you will have a higher monthly payment, so you need to take that into account when deciding which loan term is right for you.
Understanding the factors lenders consider when assessing loan applications can help increase your chances of success. If you think any of the above factors may be affecting your chances of approval, take steps to improve them before you apply.